How should investors prepare for a late-cycle environment?

As central bankers around the world begin to withdraw quantitative easing (QE) and raise interest rates, some fund managers and economists have become concerned that markets may be entering the latter stage of the cycle.

Bank of America Merrill Lynch (BofA ML) noted that this has become the biggest concern among investors, as the chart below shows.

Source: BofA ML Global Research

While BofA ML investment strategists concede that markets have reached a late stage, they argue that there is still room for further growth.

Below, FE Trustnet asks several experts which funds and strategies might perform well in a late cycle environment and those they have backed given the current market conditions.

Mark Dampier (pictured), head of research at Hargreaves Lansdown, said trying to call where we are in the market cycle is difficult for any investor, making fund selection a challenging process.

“If you do want to try to call the business cycle, the most obvious place to invest is Sanditon, they do look at the cycle and invest accordingly,” he said.

“It does mean that they’re not always right – they’re often a bit early, which they appear to be at the moment, which means their funds don’t perform as well.”

Dampier said that he is not keen on themed funds as they tend not to work out very well, further noting that “any fund is going to suffer at some stage”.

Dampier said there have been plenty of interesting developments in markets more recently with some stocks offering attractive entry points.

“For investors, you either go passive or you stick to some good fund managers and let them get on with it,” he said. “We wouldn’t alter a portfolio [for a shift in the cycle], we would hope that the managers we are invested in would move some of it accordingly or we have such a range we would blend it through.”

Darius McDermott (pictured), managing director at Chelsea Financial Services, said it may still be too early to call the end of the market cycle but wasn’t too early for investors to take appropriate action.

“Equities seem to be peaking and hence you’re really looking for caution and diversification,” he said, highlighting several alternative strategies that investors may want to consider.

McDermott said it can take long and short positions in UK equities and as such is able to take bets on market direction. The fund is benchmarked against the FTSE All Share index.

Performance of fund vs benchmark over 3yrs

Source: FE Analytics

Another fund investors may wish to consider is the five FE Crown-rated SVS Church House Tenax Absolute Return fund, which invests across a range of asset classes and is able to protect capital by holding high cash weightings.

“If you’re thinking about the late market cycle, the other thing to think about is your equity component,” McDermott said. “You could look at lower beta plays, lower risk equity plays and something like the Polar Capital Global Insurance fund.

“Insurance is a fairly stable business. Even if markets get choppy, it tends to defend on the downside.”

He added: “I find markets difficult to read at the moment, like most people we’ve been waiting for this late correction, which looked like it came in late January and February. But lo and behold, European and UK equities bounced again up to a stage where they really do look heavily valued.”

Andrew Merricks (pictured), head of investments at Skerritts Wealth Management, said that some investors have been calling the late cycle for the past five years, so instead he has tended to focus on longer-term investment themes, regardless of where we are in the cycle.

“One of my favourites has been the Cyber Security ETF which has just been purchased by Legal & General from ETF Securities,” said Merricks.

“Also, the Robotics & Automation ETF again recently coming under the L&G brand from ETFS. The graph shows why we hold them.

“Each has gone through a period of selling off as valuations got stretched, yet because the themes remain intact, they recover and resume their upward trajectory once more.”

Merricks explained: “Who is to say when the cycle ends? We can’t tell, but is increased automation or the cyber security threat ending its cycle? We can’t believe either is, so as a long-term investment it makes sense to us to hold them through periods of weakness.”

He said that these funds have targeted broader index exposure as they are relatively new sectors, where it is unclear which companies will come to dominate in the fast-moving technology space.

“By holding the sector, we will join in the growth of the dominant companies whichever they are., said Merricks. “An active manager may well deliver more success but they also run the risk of selecting the ‘wrong’ sector stocks.”

Despite being uncertain about how long the current cycle has left to play out, Merricks said the firm is considering taking a tactical value tilt within the portfolios it manages and has added another ETF, the iShares S&P 500 Industrials Sector UCITS ETF.

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